First of all, what is a Management Buy Out (“MBO”)? An MBO is a deal whereby the company’s management team purchases the assets and operations of the business they manage.
MBOs can range from small deals where, in essence, the owners are looking to step back from day to management through to large “corporate” transactions.
Small deals often occur where there is a good underlying trade, but the current “owner-mangers” wish to retire or move away from the business. There are plenty of MBOs that involve little by way of a financial transaction, as the business does not have the profits to merit that. This is often the case where a small business provides sufficient income to pay a decent wage to the working owners, but little more. In the instance advice is still required where a business changes hands, particularly from a tax perspective.
Larger “corporate” MBOs are often attractive to management because of the greater potential rewards from being owners of the business rather than employees. MBOs are often an attractive exit strategy for large corporations who wish to pursue the sale of divisions that are not part of their “core” business, or by larger private businesses where the owners wish to retire.
MBO ca require significant finance, and is usually a combination of debt and equity that is derived from the buyers, financiers and sometimes the seller as well.
What makes for a successful MBO? Here we are looking at MBOs that will require funding to deliver a result.
Profitability. The business needs a track record of profitability and cash generation – and one that the new ownership team believe they can improve on. MBO finance is heavily based around the expectation the company will deliver cash to repay loans quickly.
A willing Vendor. It’s very difficult to execute an MBO unless the existing owners see it as preferable to other forms of sale, and where they also have plenty of faith in the management team’s ability to deliver on plans. Vendors have alternatives of course, not least selling to a competitor. However, vendors will be nervous about approaching competitors and disclosing sensitive information.
Strong Management Team. The team will need the full range of skills that are required to run and grow the business; it’s important that they expect to have no reliance on the vendors from this perspective, so some recruitment can be required to fill gaps.
Know your risk factors. MBO finance will include due diligence focusing heavily on both the strengths and weaknesses of the business and the management team. MBO backers take considerable risk, and avoid businesses that have risks that have not already been addressed by management. Such risks include the emergence of competing technology and over-reliance on specific customers or suppliers.
There tends to be up to four primary forms of finance involved in an MBO transaction:
Investment/Equity put in by the Management Team – often referred to as “skin in the game”. The amounts are not necessarily significant in terms of the whole deal, but will certainly be meaningful to the manager involved; other investors want to see “belief and commitment” and cash is a straightforward way of showing that. The amounts involved might be equivalent to six months’ salary, but there is no standard approach.
Vendor Finance. Vendors often take part of the sale consideration in the form of a loan – paid over a period of time. Most vendors would prefer cash “up front”, but that’s not always feasible. In addition, other investors often make this a condition for the whole deal.
Bank Finance. In reality, bank finance involved in an MBO should be seen as similar to any other bank loan. The availability of bank finance is dependent on the business being able to pay interest and capital when expected, once the MBO has completed. There are sources of specialist bank finance in this area – providers used to working alongside private equity suppliers as part of the overall deal.
Private Equity. Private Equity and Venture Capital firms invest in MBOs because they can see substantial capital growth and a relatively fast exit (around five year’s is often quoted). Such firms will supply both loans (preferential and interest bearing) as well equity. It is the latter where they will make their return.
Find out more about Private Equity and Venture Capital through our information guides, and take a look at some of the relevant Funder Microsites.
